The global private equity market has exploded in size over the course of the last decade. According to Dechert LLP’s Global Private Equity Outlook 2019, supportive credit markets, low interest rates and a series of elongated economic booms across a range of key markets helped to facilitate more than 5,100 buy-out deals and $1.14 trillion worth of dry powder in 2018 alone. Yet believe it or not, 2019 is shaping up to be an even bigger year for private equity firms – and it will have major implications for corporate treasurers and group financial leaders.
Researchers at S&P Global estimate fund managers now have a record $2.1 trillion in private capital they’ll be looking to invest in the months to come, and they’re spending it at an incredibly fast rate on increasingly competitive and costly acquisition deals. While this is great news across the private equity landscape, it’s also worth pointing out there are plenty of threats to growth out there on the horizon. Debt is becoming more expensive, and spiralling buyout costs have made it difficult for firms to keep their loan-to-value ratios under control.
That means private equity groups are under more pressure than ever to deliver positive returns for investors – and those pressures are being passed down to the companies owned by private equity groups. Those companies are now being expected to create new paths to increased enterprise value, deliver bolder efficiencies and effectively fund strategic investments faster than ever before. Trickier still, treasurers and corporates are feeling the heat to generate enough cash to accomplish these objectives without taking on any additional debt.
It goes without saying this poses a serious challenge for treasurers attempting to put the pedal to the metal and deliver for private equity groups. One solution is supply chain finance, and there are several ways it’s helping private equity-owned companies achieve positive returns fast.
Paying down debt
Borrowing has been relatively cheap for a long time, which is why it’s been such an attractive way to generate quick cash for expansions, acquisitions and stock buybacks. That’s why, according to Securities Industry and Financial Markets Association data, corporate debt has shot up from $4.9 trillion in 2007 to nearly $9.1 trillion in 2018. Yet now that central banks are starting to allow interest rates to climb and global economic uncertainty is on the rise, private equity-owned companies are facing enhanced pressures to deleverage quickly and effectively.
Under normal circumstances, companies might turn to workforce reductions or slash operational infrastructure in order to find savings and pay down debt – but with supply chain finance, companies don’t have to.
“Companies need their balance sheet to work for them, and they need to deleverage quickly and effectively,” explains Mitchell Leonard, the former CFO of ECI.
“Supply chain finance programs provide private equity-backed companies with another financing trigger that has the potential to create incremental value without incremental capital which maximises investment returns.”
Simply put: supply chain finance enables companies to improve cash flows and deleverage rapidly and sustainably in order to make a sizeable impact on debt-to-EBITDA ratios without sacrificing growth.
Diversifying corporate funding
After a decade of recovery and supportive borrowing conditions, the global economy is finally beginning to slow down. The US Economy is expected to shrink in 2019 and 2020, and so companies and the private equity groups that have invested in them are beginning to think twice about the sustainability of their financial positions.
One of the quickest and easiest ways to clean up and maximise a company’s financial ability is to open up the number of funding options available. Commercial lending products, early payment programs and dynamic discounting all offer unique funding opportunities – but treasury teams would do well to add supply chain finance to that mix, as it tends to offer cheaper funds that will ordinarily make a far bigger impact on a company’s overall working capital.
“Supply chain finance is great because it expands existing supplier/customer partnership dynamics and you’re not concentrated on just one source of funding,” says Leonard.
In fact, supply chain finance programmes offer private equity-owned companies flexibility to change their respective funding structures as risk profiles evolve. For example, industry leader PrimeRevenue offers solutions with multibank capability that hands companies access to more than 80 financial institutions worldwide. That being said, some programmes don’t even require banks, and can be totally self-funded by the buyer. That flexibility is invaluable from a treasury point-of-view.
Funding strategic acquisitions
Freshly-acquired companies often face immense pressure to achieve lofty growth objectives post-buyout – and acquisition is one fast way to accomplish that and deliver positive returns. But when a company is fully leveraged or doesn’t have a brilliant investment-grade credit rating, borrowing in order to fund acquisitions may often be unattractive or downright impossible.
According to ECI’s Mitchell Leonard, supply chain finance offers an attractive alternative because it enables a company to free up working capital that can subsequently be reinvested in strategic acquisitions or crucial research and development initiatives at speed and scale. Above all else, it’s important to note that supply chain finance is not a loan, and thus is a way to fund acquisitions without increasing debt.
Pressures to bolster R&D activity in particular have been growing in recent years as private equity groups shift their focus from short exit timeframes to more strategic, innovative and investment-heavy growth as means to maximise exit profitability.
Achieving value creation targets
Above all else, value creation is the number one priority for all freshly acquired private equity-owned companies. Because private equity groups often set strategic targets that are not necessarily aligned with management projections and expectations, treasury teams must exhibit intensive financial agility to adapt and stay. Yet as economic volatility continues to increase in key markets across the globe, it’s getting harder for teams to deliver on big value creation targets because most of those goals require access to major cash.
Ever-increasing socio-political uncertainty surrounding the UK’s impending exit from the European Union, Donald Trump’s trade war with China and slowing Asian markets all pose huge barriers. But again, supply chain finance offers companies a substantial advantage in helping neutralize the cost impact of these challenges as well as achieve value creation targets. It ultimately provides corporates with a financing alternative that not only poses a far lower risk, but also has a lower interest expense and has a positive impact on debt-to-EBITDA ratios.
At the end of the day, no two companies are alike – and so the ways in which newly acquired companies attempt to deliver higher value for private equity groups will vary wildly, too. Yet regardless of the methods by which companies try to enhance returns, execution must be both fast and efficient. Whether it’s paying down debt, funding acquisitions or simply safeguarding against economic uncertainty through funding diversification, supply chain finance can optimise a corporate’s working capital in a way that quickly delivers positive returns for private equity firms.